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Fall 2022 Midterm Class Test on Mergers and Acquisitions- Finance, Auburn University

Here are six essential questions and answers from the midterm class test done in Auburn university in the Fall of 2022. This was a finance exam focusing on the topic of formal procedures used in mergers and acquisitions in both public and private companies. The blog is set in a way that will enlighten you on how best to do your finance exams. We are also an exam writing service and you can hire us at any time to take your exams on mergers and acquisitions.

Discuss in detail the concept of sale by a receiver or liquidator for private companies

If a business encounters financial difficulties, it may come under the control of a receiver or liquidator whose main responsibility is to realize funds for lenders and other creditors within a reasonably short period. This may present an opportunity for an acquisition at an attractive price. The receiver may take the view that the value of the business will rapidly diminish unless a speedy sale can be concluded.

The sale of a business as a going concern is likely to generate more cash than selling assets piecemeal. It is also a more convenient and usually quicker process. However, a purchaser may be reluctant to buy a business with its associated liabilities and commitments, some of which may be difficult to quantify.

To facilitate a sale, a new subsidiary of the failed group may be set up by the receiver, and the relevant assets hived down to the new company. The new company will have a low share capital and the consideration for the assets hived down will be left outstanding and perhaps undetermined for the time being. If a purchaser agrees to buy the business he will purchase the share capital of the new company for a nominal amount and provide funds to it to satisfy the debt to its former parent. The debt will at this stage be crystallized at the amount that the purchaser has agreed to pay for the business.

Through the hiving down procedure, the purchaser can buy a business that starts with a clean sheet, and the liabilities and commitments of which can be precisely assessed. This method is perhaps most appropriate for manufacturing concerns where stocks form a considerable proportion of total assets. If operations cease, much raw material and practically all work-in-progress may be valueless Customers may no longer be willing to take finished goods unless they are contractually bound to do so in case after-sales service and support are lacking. In these circumstances, the receiver, who may not have much practical experience in that particular industry, may well take a view of value that leaves some margin for a company engaged in a similar line of business to make an advantageous purchase. It is desirable that the purchaser should be able to assess the risks for himself. It is unlikely that the receiver or liquidator will be willing to give any warranties and to obtain a warranty from the vendor, the failed group, serves little purpose. In addition, it is unusual for a receiver or liquidator to accept any other terms of payment than cash.

What are some of the pre-emption rights and restrictions on share transfer that a private company may set?

The articles of association for a private company may well contain a pre-emption clause laying down procedures that a shareholder wishing to sell shares must follow. For example, a typical clause might provide that a vendor of shares must notify the directors of his intention and his opinion of a 'fair value for the shares and appoint them as his agents for the sale. The directors may accept the opinion of value or request independent professionals such as the auditors of the company of a merchant bank to establish a fair price. This exercise will be done on a willing buyer, willing seller basis, taking into account the limited marketability of the shares in a private company. The result could be a lower figure for fair value than a shareholder expects.

Once a fair price has been established, notice is given to all other shareholders in the company of the number of shares to be sold and the price asked. Each has the opportunity within a certain period to state what maximum number of shares he wishes to purchase. The directors will then allocate the shares available on a pro-rata basis, allocating any surplus shares to shareholders who have indicated they wish to purchase more than their pro-rata entitlement. If all the available shares are not sold in this manner, the directors may well have a right to sell to a third party within some specified period, say one month. Only after these procedures have been exhausted is the vendor free to sell the shares to a third party of his own choice.

Whether or not there is a pre-emption clause and whether or not the pre-emption procedure has been followed, the directors may still have the right to refuse to register the transfer of shares without giving any reason for their action Without the purchaser being able to have his holding registered, it will be impossible to complete the transaction Consequently the full co-operation of the board of directors of the company is in practice needed.

It will readily be seen that these provisions can create major problems for a purchaser who is seeking to acquire less than 100% of a private company. He can only carry the transaction forward to a certain stage and then has to await the pleasure of the existing shareholders. At the end of the day, the purchaser may feel that if the shares are worth buying they are almost certain to be bought by one of the parties who has the right of first refusal. The vendor too is at a severe disadvantage. Once he has indicated he wishes to sell he is at the mercy of an expert whose view he cannot challenge setting a price for the shares which he believes is too low. In addition, he is forced to impose on the purchaser a significant delay while the pre-emption procedures are exhausted.

Lists the main sections included in a typical sale and purchase agreement

The transaction negotiated between the principals is embodied in a sale and purchase agreement set out in the form of a legally binding contract between buyer and seller. A typical sale and purchase agreement will include the following main sections:

  1. The identities of the parties to the contract, recitals giving brief background information on the transactions and definitions to assist in the reading of the contract.
  2. A description of the assets being sold and purchased and the price being paid.
  3. Any conditions to which the contract is subject.
  4. How, where, and when completion of the contract will take place?
  5.  Any warranties and undertakings being given by the parties to the contract.
  6. Other standard clauses deal with such matters as governing law, notices, costs, and announcements.

The details of what is being purchased, the price to be paid, and how it is to be satisfied will have been the subject of intensive negotiations between the principals probably long before the involvement of lawyers. For this reason, these sections of the contract rarely cause difficulty at this stage. If they do, it is a sign that the negotiations have not really been concluded.

The conditions to which the transaction is subject will usually have been discussed, though they may not have been expressed in precise detail. Putting them down on paper may have the effect of making one or other of the parties believe that negotiations are being reopened. Some agreements have so many conditions that it is questionable whether it is worthwhile to proceed with a formal agreement at that stage. It may be better to try to satisfy the major conditions in advance, to establish that the transaction is a realistic one.

What are the areas covered by the warranties given by vendors in sale and purchase agreements?

The area which frequently causes the most difficulty is the question of warranties to be given by the vendor. It may not be relevant for the purchaser to give any warranties, particularly if the purchase is for cash. Assurances may be obtained that the purchase has been properly authorized according to the purchaser's internal rules and any external regulations, if applicable. The vendor on the other hand is likely to be asked to warrant the condition of the business being sold in considerable detail. The areas that warranties will cover include the following:

  1. That the balance sheets and other financial information provided about the company and its subsidiaries are correct and complete, and that there have been no material adverse changes since the date on which the information has been provided.
  2. That there are no material capital commitments, unusual contracts, guarantees, or any other contingent liabilities outstanding, including current or threatened litigation.
  3. That the books and records of the company are correct and have been kept up-to-date and that all tax returns and other statutory returns have been made.
  4. The group has good and marketable titles to all its assets and they are fully insured.
  5. That the group has complied with all leases and other agreements.
  6. That no shares of the company are under option and that there are no outstanding rights to subscribe for shares or securities convertible into shares.

A vendor will wish to limit the warranties as far as possible and put a time limit for any claims to be lodged. The purchaser will wish to make the warranties as broad and open-ended as he can. He may also seek to retain some of the purchase money to offset possible claims under the warranties.

Discuss the concept of management buy-out with reference to private companies

A buy-out by management (or any other group of investors) can be carried out in the context of a listed company as well as in a private group. However, if a publicly listed company is purchased the checks of the marketplace will apply. If the price agreed is too low, a rival bidder will be attracted once the proposals are announced and it is clear that the company is in play. In the case of a private company the price at which the sale is made may not be published and it is less easy to determine whether it is fair.

 A diversified group may find it more practical to sell a subsidiary or division to an existing management team than to a third party. By taking this route they avoid potentially strengthening a rival group Negotiations can be handled in-house and no information needs to be provided outside the group.

 One of the main problems is likely to be finance Management may not be able to put up more than a small proportion of the funds needed which may, however, be a very significant percentage of their own savings. It is likely therefore that they will need to attract further equity partners.

 When management buy-outs first became popular the price of the buy-out tended to be reasonable and the backers specialists who were prepared to try to understand the business and play a continuing role in support of management. As the early transactions prospered, more deals were proposed and the weight of institutional funding which became available put pressure on prices.

A typical buy-out is likely to have a multi-tiered financing structure. High gearing is inevitable as the management group will want to retain voting control of the vehicle used: The financiers may also prefer management to have the deciding say in running the business. The pure equity base may therefore be very low Next will come lenders with some rights to convert into equity or warrants to subscribe for shares. They will be prepared to sacrifice some immediate income for the prospect of capital gain. The top tier is outright lenders, commercial banks, or institutions, who will expect above-average interest rates to compensate them for the risks involved. Their attitude will be influenced by whether they can. obtain direct security over the assets of the business being acquired which is not possible in all jurisdictions.

The former parent of the business being bought out may have to provide some assistance Documentation may include a technical or services support contract with the former parent covering for example design nights or computer facilities until the newly independent organization can develop all its own functions.

Explain two methods through which a public company can be acquired

Acquisitions of less than 100%

  • Dawn raids

The technique of buying a significant stake in the market rapidly and from as few shareholders as possible is called a "dawn raid' Stockbrokers with major institutional connections will be key members of the war party. The percentage of a company that may be purchased in a dawn raid is restricted in some countries and disclosure must be made when certain levels of shareholding are reached.

 The effect of disclosures and enforced delays in the pace at which a significant stake can be built up have to some extent limited the effectiveness of the dawn raid as a tactic. However, despite changes in regulations, the acquisition of strategic holdings from major shareholders with whom negotiations are held privately can be a major blow to the target company's morale and a major boost to the offeror.

A dawn raid can have some drawbacks for the offeror. Depending on the percentage acquired, a raider may not be permitted to make a full bid without providing a cash alternative equivalent to the highest price paid for the shares during say the previous six months If certain trigger points are reached, the purchaser may be required, whether he wishes it or not, to extend an offer to all other shareholders, in cash or with a cash alternative at the highest price paid.

  • Partial offers

An offeror may have the option to make either a full or a partial offer. A partial offer may be made for any nominated percentage of a company's share capital, but usually for over 50%.

Market enthusiasm for partial offers varies widely. In the US, they are frequent. In the UK and other countries which have adopted broadly the same system in the securities markets, the practice is to date relatively rare. It may not be permitted at all if substantial purchases have been made from the market in advance of the offer.

A partial offer is normally conducted on a tender basis. The offeror either fixes the number of shares he wishes to buy or may indicate a range, with a maximum and minimum. He will also stipulate the price he is prepared to pay. Shareholders can tender any or all of their shares to the offeror.

If the offeror receives less than the stated minimum number of shares, the tender will lapse. If he receives a greater number, acceptances will be scaled down proportionately so that the offeror only purchases the number of shares he desires. A shareholder tendering all his shares may succeed in selling a larger percentage than the percentage for which the offer is made if other shareholders do not tender all their shares.

From the offeror's point of view, the procedure reduces the amount of funding required as compared to a full offer. As a minimum percentage of the shares will remain in public hands, the tender offer method ensures that the shares of the target company will continue to have a degree of marketability.

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